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2012: The Year Few Got Right

There's nothing special about a year. It's just the time it takes for the earth to circle the sun. But we use the calendar to make all kinds of judgments and predictions, forecasting what we think will happen over the coming 365 days.

The first week of 2013 has seen a flood of articles prophesying the events of the next 12 months.

Rather than insult you with another list of predictions for the year ahead, I find it more valuable to look back at how some of last year's prediction lists fared. A year ago, analysts were making a variety of predictions, but there was one common theme: Most of them were wrong. Dead wrong.

So let's review some of last year's biggest predictions that never came true -- not because we want to point fingers, but because you can often learn more from people's mistakes than from their successes.

1. Barron's: Interest rates will riseA year ago, Barron's began its "2012 Forecast" article with a prediction that left no wiggle room: "Yields on 10-year Treasuries don't have anywhere to go but up in the next year."

But there was another place they could go: down. And that's where they went. Interest rates on 10-year Treasuries began the year at 1.97% and closed at 1.73%.

Treasury bonds have been in a bull market for 30 years. Someday that will end, and interest rates will rise. But no one knows when, and trying to predict a turn is maddeningly difficult. U.S. Treasuries have gained more than 20% since America's credit rating was downgraded in 2011 -- the opposite outcome of what almost everyone expected. Traders have been predicting the end of low interest rates in Japan for nearly two decades, and for nearly two decades, they've been wrong. These things can last much longer than anyone expects.

2. Todd Schoenberger: Stocks to crash 35%A day before Christmas 2011, analyst Todd Schoenberger said, "We're predicting the S&P 500 will be down 20% by mid-year, and by the end of the year, we'll be down 35%. ... Buyer beware."

The S&P 500 (SNPINDEX: ^GSPC) finished the year up 14%. The Dow Jones Industrial Average (DJINDICES: ^DJI) gained 10%. Far from "buyer beware," the reality was "buyer, prepare for one of the best years of the last decade."

Stocks will crash again someday. Count on it. But again, the when is virtually impossible to predict. The key to successful investing isn't predicting when a crash will occur, but rather being ready for one when it inevitably comes -- preparedness, not prescience.

3. Lakshman Achuthan: A recession is hereLakshman Achuthan, who heads economic forecasting firm ECRI, made a bold and succinct call in September 2011: "If the United States isn't already in a recession now, it's about to enter one." Some other highlights:

And he even put a time frame on his call. In December 2011, he said: "If there's no recession in Q4 or the first half, then we're wrong. You're not going to know whether or not we're wrong until a year from now."

Well, it's a year from then, and there's no recession. By most measures, the economy is strengthening.

There will be recessions in the future -- that's guaranteed. But you can never predict something as complex as a $15 trillion economy with 315 million citizens and 20 million businesses with precision or certainty. Maybe recession will come this year. Maybe next. Maybe we'll enjoy a decade-long boom. Achuthan's error wasn't his analysis -- he's a smart economist -- but rather the unwavering confidence in his analysis. There is a counterintuitive rule of thumb regarding forecasters: The more certain they are of their big predictions, the less weight you should give them.

4. Greece will leave the EuroMany made this prediction a year ago. Citigroup (NYSE: C) predicted that Greece would leave the euro on Jan. 1, 2013 (it didn't). In December 2011, London mayor Boris Johnson predicted a Greek exit as well. The BBC wrote:

"I would be amazed if we were all sitting here next year and the euro had not undergone some sort of change," Mr Johnson [said]. ... "I think it highly likely that there will be a realignment in the sense that some countries will fall out ... and we all know who the likely candidates are," he said, adding that ouzo (a Greek drink) would be "substantially cheaper" in a year's time.

Here's a good rule of thumb for what's going to happen in Greece: No one has any idea what is going to happen, ever. The forces that dictate events like Greece leaving the euro are political, not economic, and no sane person would ever claim to understand the irrationality of a politician's mind. Nassim Taleb once wrote: "The best test of whether someone is extremely stupid (or extremely wise) is whether financial and political news makes sense to him."

Bonus fact: Greek stocks returned 33% in 2012, making it one of the best regions in the world to invest in.

Hot air galoreGo down the list of pundit predictions, and you'll find this same story again and again. The track record of financial experts foretelling the next 365 days is dreadful -- so bad, in fact, that assuming the opposite of what they predict may be the best strategy. If I could offer two tips on how to react to analyst predictions, they would be:

Avoid those who talk in certainties. The most reliable forecasters think in probabilities. Saying a recession is guaranteed this year is ludicrous and ignorant of history. On the other hand, saying there's a 70% probability of a recession may be a prediction worth paying attention to. They are vastly different calls.

Listen to people who talk about their mistakes. One of the keys to making good forecasts is constantly updating your thoughts when new information arises. That can mean changing views entirely. In 2009, CNBC host Larry Kudlow proudly announced, "I have not changed my point of view for my entire adult life." I struggle to think of a worse trait for someone hoping to understand the world. The guy you want to listen to is the one who is constantly saying: "I was wrong. Here's why, and here's how it's changing my outlook."

Here's to a happy, safe, healthy, yet most unpredictable 2013.

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.

Editor's Note: An earlier version of this article incorrectly reported the 2012 return for the Dow Jones Industrial Average. For 2012, the index returned 7.26%. With dividends reinvested, the return was 10.24%.

Comments from our Foolish Readers

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Another day, another article by Morgan about how the pundits got it wrong. It is good to remember how bad they are and I especially like the "avoid those who talk in certainties." When is the last time you heard a pundit say "I don't know for sure, but this is my best guess." For some reason that phrase does not exist in their vocabulary.

It's pretty easy to criticize the predictions of others with the gift of hindsight. Of course, had all of those predictions came true, you could have still written this article, just about the incorrect predictions others made that the stock market would rise, interest rates would fall, and greece would stay in the Euro, because surely somebody out there predicted those things too.

smartmuffin, the whole point is that it is pointless to make non-probabalistic predictions. (Those who correctly predicted that Greece would remain in the Euro (ie, Bill Ackman) did so probabalistically.)

A refusal to make non-probabalistic predictions therefore does not contradict the analysis, or weaken it, or signify some sort of hypocracy, as you seem to think. Rather, such a refusal confirms the analysis is consistent with its premise.

It is perfectly reasonable to make predictions, and we all do. Whether or not we are aware of it we often are making probablistic predictions, whenever we decide matters like position-sizing and diversification and even buy/sell dates. The people by contrast who speak in certainties often have no money riding on their calls, and get paid for being provocative, not right.

What's really sad is when you see fund managers who have started down the road of certainty. Some of those are Hussman, David Merkel (who I have stopped following on Twitter), the Alhambra Investments guy, etc. These guys are so anti-Fed, so dogmatically, that I think they have done their investors a disservice. (And Hussman manifestly has, based on his returns. That poor guy started getting into arguments about how what the Fed had done was illegal, which had nothing to do with his models, and which likely caused deviations from them.). By contrast, after Bill Gross made his famously wrong Early 2010 bearish call on Treasuries, he turned practically on a dime and bought Treasuries, while acknowledging his bearish thesis may (it will) play out at some future date.

To me, right now the people with most credibility in the markets and on economic issues are: Warren Buffett, Jeffrey Gundlach, and Ray Dalio. Everyone else is basically noise to one degree or another, though even these three are to some extent. Second tier would be the guys at GMO and Pimco. Best predictive blogger seems to be Bill McBride (though his housing calls have been uncomfortably certain and he'll go off the rails eventually) followed by Miller at A Dash of Insight.

Although it is impossible to demonstrate whether a market is efficient, i.e. if all the information is priced into the share price, we are able to see that there is a group of investors (Value Investors) which has systematically achieved better results than the market. They all have the same characteristics:

Your duplicitous reference to Larry Kudlo cheapens your otherwise good article. You should be able to understand that Larry was talking about his point of view on values, not making some absurd claim to be able to predict the future.

I don't know if I want to listen to the guy who is constantly saying "I was wrong".

I'd prefer someone who is right most of the time but can admit their mistakes, so that every once in a while they are saying "I was wrong and here's why."

I'd agree that you shouldn't make investment decisions based solely on analyst predictions, but I think there's value in reviewing their reasoning, and seeing why they are predicting what they are predicting. I like listening to people talk about Elliot wave theory solely for the entertainment value.

The predictions and business commentary is so so bad, I pity the investor who listens to any of it. It's all bad noise. Invest in solid dividend paying great companies and turn off all the news except motley fool.